Iceland Melts Down

...The three banks—Glitnir, Landsbanki, and Kaupthing—embarked on a course of aggressive foreign expansion, gathering overseas investors attracted by Iceland’s high interest rates...

...Since they can’t convert their savings out of kronas and kronas are worthless outside of Iceland, they’re converting their money into cars—four-wheeled investment vehicles, if you will—and shipping them home...

...Prime Minister Haarde waged an unhelpful war of words with Brown and publicly belittled the IMF, saying that he would not seek its help, but might consider a plan if they wanted to offer one...

...In the span of ten days, Oddsson had turned a crisis into a disaster, but the rest of the government didn’t exactly cover itself in glory...

...What I can say is the longer this situation maintains, the more likely it is that good and sound companies will become casualties...

...Where foreign suppliers used to do business with Iceland on 30-, 60-, or even 90-day lines of credit, they now demand non-krona cash in advance...

...It’s typical, the men make the mess and the women come in to clean it up...

...But Falk points out that the supply of goods is immaterial, since no one can afford to buy them...

...Iceland’s leaders made the situation worse...

...They were not weighted down by the subprimedebt packages—excuse me, structured investment vehicles— which caused so much trouble in America...

...Others are more pessimistic...

...While the krona is off the currency markets, all banking is run through the central bank, putting a premium on foreign coin...

...In a fi nal act of economic malpractice, Oddsson cut the central bank’s interest rate from 15.5 percent to 12 percent, a move which had no practical effect except to announce that Iceland was resigned to high infl ation...

...The seizure killed Kaupthing, the one bank which still had life in it...

...And then the personal bankruptcies will begin...

...Icelanders vary in their outlook...

...The result is that construction sites around the city are closed or being operated by skeleton crews...

...Prime Minister Haarde told Icelanders that they’re in for a rough few weeks, but that the situation will improve...

...Not to mention the money the government will need to put aside to pay back the IMF loan...

...For instance, Geir Matthiasson, a professor of economics at the University of Iceland, notes that hospitals are prescribing smaller amounts of drugs and requiring more frequent refi lls in order to maximize the reserves of medicines on hand...

...Suddenly, the Icelandic government was holding $61 billion of bank debt—roughly 8 times the national budget...

...Kringlan’s many designer boutiques were deserted...

...Which brings us back to the individual consumer...

...The grocery stores are fully stocked...

...Sale of the krona was halted on currency markets...

...Forty-eight hours later, it went down...

...The government nationalized it, too...

...In the big-ticket capital sector, the outlook is positively macabre...

...airbase at Kefl avik in return...

...GDP will almost surely fall a bit, but it shouldn’t collapse...

...The government took it over the next day...

...Not that Icelanders would likely be able to afford her wares, anyway...

...Foreigners cannot trade in their kronas...

...Another Icelandic economist, Gylfi Magnusson, is more optimistic: “There’s certainly going to be a real contraction with unemployment...

...Thorsson also sees a shift in where shoppers are spending their money: high-end is out...

...Now it’s 280 krona...

...Sigurjon Orn Thorsson, the mall’s general manager, says that the number of visits remains roughly constant, but that spending is off sharply from a year ago...

...It was a diffi cult and perilous moment...

...The worst is yet to come...

...At Kringlan, the main shopping mall, you can walk past four or fi ve stores in a row without seeing a shopper...

...While Haarde postured, the Icelandic stock market collapsed...

...The maximum it could go would be 30 months,” he says...

...They are leaving by the boatload, either laid off or fi nding Icelandic wages now lower than what they can make at home...

...Because of all this, Landsbanki failed a week later...

...Three-hundred thousand Britons socked away ?4.6 billion ($7.8 billion) in Icesave alone...

...The sandwich I buy for lunch across the street was 220 krona last week,” she says...

...But their reliance on foreign investment left them dangerously exposed to disruptions in the credit markets...

...In an odd twist, there has emerged a small market for used cars...

...More unemployed means more government expenditures in benefi ts...

...BY JONATHAN V. LAST On October 6, Iceland’s prime minister, Geir Haarde, claimed his country was on the verge of “national bankruptcy...

...Since January the krona has declined 64 percent against the euro, so he’s raised vehicle prices by 25 to 30 percent...

...Short-run funding for Glitnir and Landsbanki evaporated, margin calls came from the European Central Bank, loan covenants kicked in...

...When the markets seized up in late September, Iceland’s banks were unable to secure loans to meet their short-term debts...

...Iceland, it seemed, was on its way to becoming a frozen banana republic...

...Businesses that rely on nonessential imports—which is almost all of them—have only the stocks they had at the end of September...

...This has prevented shortages of essentials, but rationing is occurring subtly...

...We sold six new cars last week—which was 30 percent of sales in all of Iceland...

...Carola Falk manages a shop that sells Icelandic handknit sweaters—which is like winning the lottery: The only two materials she needs are sheep and old Icelandic ladies, both of which remain in strong supply on the island...

...As of August, doesn’t give an accurate picture of present reality...

...Oddsson stepped in again, attempting to peg it at a rate of 131 krona per euro...

...In another political maneuver, he intimated that the Icelandic banks might not be able to pay their U.K...

...Even before the crisis, that number had jumped 50 percent...

...In 2007, Hekla sold 9,000 vehicles, used and new...

...There is already a surplus of 2,000 to 3,000 fl ats, which, combined with outmigration, foreclosures, and, of course, infl ation, means you have a housing market headed for trouble, too...

...Hauksson buys his vehicles in euros...

...Hauksson hopes it’s only two years...

...Offering greenbacks to merchants doesn’t trigger any under-the-table discounts...

...At its height in 2007, the OMX Iceland 15 was trading at 9,000 points...

...The banks alone contributed $330 million to the government’s coffers last year...

...As Richard Porkes explained in the Financial Times, “This triggered a sovereign debt downgrade and a sharp further fall in the already depreciated krona...

...In the midst of the crisis, the country’s two biggest newspapers merged as ad sales evaporated overnight...

...Jonathan V. Last is a staff writer at THE WEEKLY STANDARD...

...Importers of nonessential goods are out of luck...

...The job market will obviously be quite bleak...

...Finnur Oddsson, managing director of the Icelandic Chamber of Commerce (and not related to the central banker), says, “It’s going to be manageable...

...investors...

...For instance, the mall has two grocery stores...

...If it’s more than 30 months, we’re dead...

...The engine of this success was the country’s banks, whose privatization was completed in 2000...

...I wouldn’t expect them to put conditions like they do in third world countries or underdeveloped economies in this situation...

...Iceland’s banks were not particularly risky constructions...

...Oddsson reacted to the situation like a politician: He declined to bail out Glitnir and pushed for aggressive nationalization...

...In an attempt to escape Iceland’s high interest rates, many Icelanders took out foreign currency loans for cars and mortgages...

...There will be higher taxes on fewer jobs paying less money...

...The Icelandic government undertook formal negotiations for a bailout with Russia, speculation being that the Russians would want the abandoned U.S...

...If you look at the scale of this economy, it’s very small...

...The government’s total budget in 2007 was $8.6 billion...

...When I visited on a weekday afternoon, the big, fancy Hagkaupf—think Whole Foods—was almost empty...

...The administration engaged in stunt casting, putting women in charge of two of the re-formed banks and playing gender politics: “Now the women are taking over,” said one government offi cial...

...And government revenues will be down...

...The combination of infl ation and contraction has already reached into every sector of the economy...

...And the worst is yet to come...

...Three weeks in, the effects are visible...

...In toto, Geir Matthiasson predicts “a decline as bad as 10 percent of GDP next year...

...The Icelandic government, having previously said it had secured a loan from Russia (it hadn’t), last Monday leaked word that it had coordinated a $6 billion loan with the IMF, Norway, Sweden, and Japan...

...When the market reopened on October 14, it plunged 77 percent in a single day, settling at 678.40...

...The bankrupt banks laid off 500 white-collar workers...

...In the midst of the turmoil, there was a run on the krona as Icelanders and investors tried desperately to trade the falling currency for harder cash...

...The head of the central bank, David Oddsson, is a politician with no background in economics...

...Knutur Hauksson is president of Hekla, Iceland’s biggest car dealership...

...Most of the construction workers in Iceland are Polish immigrants...

...Construction has ground to a halt as builders fi nd themselves strapped...

...Iceland’s fi nancial crisis had become an economic crisis...

...This week will probably be zero...

...Polish immigrants leaving Iceland are buying them...

...Or consider auto sales...

...Icelanders can only exchange krona for other currencies if they can prove they are about to travel abroad...

...This prompted Gordon Brown to lockdown Icelandic assets in the U.K.—using a provision originally crafted as part of a post-9/11 anti-terror statute...

...That loan never materialized and on Friday, Haarde announced that the government would begin negotiations with the IMF for $2 billion in immediate aid—leaving Russia’s generosity blessedly untouched...

...Every day the Icelandic government auctions off 25 million euros, which are prioritized for the import of “necessary” goods—food, medicine, and gas...

...Already, the infl ation rate was ripping along at 14 percent...

...But Oddsson wasn’t fi nished...

...No one knows how high it will be by the end of the year...

...The reality is somewhat less hysterical...

...The question,” he sniffed, “is what kind of program [the IMF] would envisage for an advanced economy like ours...

...Icelanders continue to work and drive and, to a lesser degree, shop...

...Hauksson is trying to ship as much of his stock as possible back to Europe...

...When Glitnir faltered first, in late September, it approached the Sedlabanki, Iceland’s central bank, for a short-term loan...

...Year-on-year real wages were down 2.5 percent before the crisis hit and will drop much further...

...For a sense of scale, Iceland has a population of 304,000 and a total annual GDP of $20 billion...

...Infl ation is already running so high that she sees the prices of everyday goods change weekly, and in some cases daily...

...The same is true of clothing...

...The combination of the krona’s strength (in 2007, the Economist estimated that the krona was the most overvalued currency in the world—by 131 percent) and the Icelandic central bank’s high interest rates (which peaked at 15.5 percent) made saving in Internet accounts, such as Landsbanki’s “Icesave” program, particularly attractive to Europeans...

...This might not sound like much, but Iceland has traditionally had very low unemployment: In 2007, the country had 1,476 unemployed people, or 0.9 percent of the workforce...

...Andres Magnusson, head of the Icelandic Federation of Trade & Services, says, “A lot of the companies will not survive—how many and which of them I cannot say...

...Defi nitely two to three years of serious recession...

...Laura Petursdottir, who runs an upscale bath and body store, says she hasn’t received new shipments in six weeks and is worried that she won’t have stock for the Christmas season...

...Nearly every industry is being crunched...

...In the next few weeks, some of the companies will go down...

...When you look at historical records, when we’ve had shocks to the economy, which has occurred a number of times, it’s bounced back very quickly...

...Before October, Iceland was an economic Cinderella story with sustained annual growth of 4 percent and the fi fth highest per capita GDP in the world...

...A store called Next, which sells discounted, off-label clothes, was humming...

...The OMX Iceland 15, their version of the Dow, stood slightly off its historic highs of 2007...

...Since the central bank had only 4.5 billion euros in foreign currency reserves, the gaudy peg was doomed from the start...

...He was mayor of Reykjavik and then prime minister from 1991–2004...

...The nofrills Bonus—a Nordic Dollar General—had every checkout lane open and packed tendeep with customers...

...One item doing brisk business elsewhere in the mall was an anti-Oddsson T-shirt...

...Members of the Icelandic government were placed under police protection for the fi rst time in the nation’s history...

...this year that number will be closer to $110 million...

...The krona, which had been trading at 122 in September before the crisis began, was at 340 when the collapse of Kaupthing brought currency trading to a permanent halt...

...Asked how many vehicles he’s sold recently, Hauksson laughs...

...Over the following days, the government was forced to nationalize the three big Icelandic banks...

...Various English-language press reports suggested that food shortages were days away...

...Hauksson explains, “We’ve seen the banks fail...

...As Eyglo Svala Arnarsdottir, an editor at Iceland Review, told me, traditional krona-based mortgages are indexed to infl ation—meaning that principal is now increasing faster than it can be paid off...

...Foreclosures will follow, unless the government prohibits them...

...Everyone here assumes the krona will soon be stabilized and traded at a “reasonable” rate, meaning that businesses will be able to import goods again...

...Next year will be very diffi cult—there’s no way to avoid that...

...With the krona collapse, those loans have increased by 50 to 80 percent...

...When it comes to home mortgages, even Icelanders who took out krona-based loans are in trouble...

...The stock market crashed, and the krona became so devalued that trading was halted...

...This is just the beginning,” he says...

...In the midst of the crisis, trading was halted for three days...

...The fi nancial crisis that began with mortgage defaults in California and Florida has wreaked havoc in the North Atlantic...

...Icelandic economists predict that 25 percent is the bestcase scenario in the near term, while their models suggest it could hit 75 percent in the worst-case...

...Brown wasn’t about to abandon constituents who were losing their savings...

...The fact that Iceland has not gone literally bankrupt, however, is the end of the good news...